Price elasticity of demand and its determinants

Price elasticity of demand: measures the responsiveness of quantity demanded to a change in

price, along a given demand curve.

Mathematically the value is negative, but we treat it as positive.

Price elastic demand (less than infinity).

Figure 2.1 - Price elastic demand

Price inelastic demand (greater than zero)

Figure 2.2 - Price inelastic demand

Unit elastic demand

%change in P = %change in Qd

Total revenue will not change when price changes (same revenue box)

Figure 2.3 - Unit elastic demand

Perfectly elastic demand, demand is zero at all but one price.

Figure 2.4 - Perfectly elastic demand

Perfectly inelastic demand, demand is constant at any price.

Figure 2.5 - Perfectly inelastic demand

Determinants of PED:
1.

Number and closeness of substitutes: more substitutes available & closer higher PED

2.

Degree of necessity (and how widely it is defined): lower the degree of necessity higher
PED; the more vague it is defined, i.e. food higher PED
o

3.

As it is more narrowly defined more subjective

Time period considered: more time to consider higher PED

o
4.

Inelastic in the short term, elastic in the long term

Income spent: the higher the income spent higher PED

Value of PED falls as the measuring points move down a demand curve. PED is not
represented by the slope of the demand curve.

Applications of price elasticity of demand

Applications of PED:
1.

Governments: if inelastic (low) PED less consequence if P impose more indirect tax

2.

Firms: if inelastic (low) PED more revenue if P price of the product rises

ncome elasticity of demand and its determinants

Income elasticity of demand: measures the responsiveness of demand to a change in consumers

income.

Shifts demand curve due to changed income

Determinants:

Normal goods: positive value of YED

Inferior goods: negative value of YED

Necessities: Income inelastic of demand

Luxuries: Income elastic of demand

Applications of income elasticity of demand

Application:
1.

Firms: can predict the effect of a business cycle on sales

Price elasticity of supply

(PES)
Price elasticity of supply and its determinants
Price elasticity of supply: measures the responsiveness of quantity supplied to a change in price
along a given supply curve.

The value will always be positive

Price elastic supply (less than infinity).

Figure 2.6 - Price elastic supply

Price inelastic supply (greater than zero).

Figure 2.7 - Price inelastic supply

Unit elastic of supply

Mathematically, any straight-line supply curve passing through the origin is unit elastic of
supply.

Figure 2.8 - Unit elastic supply

Perfectly elastic supply, only supplied at a certain price level.

Figure 2.9 - Perectly elastic supply

Perfectly inelastic supply, supply is constant at any price level.

Figure 2.10 - Perfectly inelastic supply

Determinants of PES:
1.

Time period considered: longer the time period considered the more elastic (time to
increase the factors of production, such as capital)

2.

Mobility of factors of production: higher the mobility of factors of production the more
elastic (easier to change to another production with less costs when price rises)

3.

Unused capacity: if more capacity productive resources not being fully used the more
elastic (increase output easily without great costs)

4.

Ability to store stocks: if able to store high level of stocks the more elastic (able to react
to price increases with swift supply increases)

Applications of price elasticity of supply

Commodities: are raw materials in the primary production. (i.e. cotton & coffee)

Inelastic PED, PES, & YED.

Higher degree of necessity, takes time to grow/harvest to increase Qs, few or no

substitutes
Manufactured products & service relatively high (elastic) PED, PES, YED.

ncome elasticity of demand (YED)

income elasticity of demand and its determinants

Income elasticity of demand: measures the responsiveness of demand to a change in

consumers income.

Shifts demand curve due to changed income

Determinants:

Normal goods: positive value of YED

Inferior goods: negative value of YED

Necessities: Income inelastic of demand

Luxuries: Income elastic of demand

Applications of income elasticity of demand

Application:
1. Firms: can predict the effect of a business cycle on sales

Cross price elasticity of demand (XED)

Cross price elasticity of demand and its determinants

Cross price elasticity of demand: measures the responsiveness of a demand for one good to a
change in price of another good.

Movement along the curve for one good causing a shift in demand for
another good

Determinants of XED:

Substitute goods: positive value of XED

Complementary goods: negative value of XED

The absolute value of XED depends on the closeness of the relationship

between the two goods. (Two goods are unrelated if XED =0)

Applications of cross price elasticity of demand

Applications of XED:
1. Firms on substitutes goods: low positive value?the better?increase price of
the product

2. Firms on complementary goods: high negative value?the better?increase

price of the product